Norges Bank to start raising rates later this year - Capital Economics
Nordic & Swiss Economics

Norges Bank to start raising rates later this year

Nordic & Swiss Economics Update
Written by David Oxley

We forecast the Norges Bank to be the first advanced central bank to begin raising interest rates, in the second half of this year. This will further bolster the krone, which we expect to be the best-performing G10 currency in 2021, and will drive the currency back above parity with the Swedish krona.

  • We forecast the Norges Bank to be the first advanced central bank to begin raising interest rates, in the second half of this year. This will further bolster the krone, which we expect to be the best-performing G10 currency in 2021, and will drive the currency back above parity with the Swedish krona.
  • Along with the US Fed, the Norges Bank was one of the few central banks with monetary space to use when the pandemic hit last year. Policymakers cut the key interest rate from 1.50% to its current record low of zero by May 2020 (see here), where it has remained since.
  • Up until now, we have forecast rates staying on hold into 2023 and we still do not think a rate hike is imminent. After all, having been above target for 13 months in a row, CPI-ATE inflation is set to ease back to 2% by the middle of the year as the impact of previous krone weakness fades. That said, we have long argued that the Norges Bank would be among the first to raise interest rates, and a combination of factors means that tighter policy is coming up the agenda faster than we had previously anticipated.
  • This is partly a function of the relative success that Norway has had in containing the virus which means that output is closer to ‘normal’ than elsewhere in Europe. Mainland GDP had recovered to ‘just’ 1.1% below its pre-virus level by December, and the prospect of a vaccine-driven boost is now likely to push it above this level by the middle of the year. Against this backdrop, while the outlook for CPI-ATE inflation is benign over the coming six months or so, home-grown price pressures are likely to pick up during H2.
  • Second, the recent gains in oil prices provide a more positive backdrop; we now expect them to rise to US$70 per barrel by end-2021 (previously $60pb, see here). Admittedly, there is not a mechanistic relationship between oil prices and monetary policy. However, the crunch from energy investment this year is likely to be smaller than initially seemed likely, and this will indirectly support manufacturers too.
  • Finally, the resurgence in house prices is causing increasing concern at the Bank. House price inflation surged from a low of 1.2% y/y in April 2020 to more than 8% currently and policymakers have repeatedly said that “a long period of low interest rates increases the risk of a build-up of financial imbalance”. They have already signalled that the emergency cut to the countercyclical capital buffer will be reversed this year, and a broader tightening in policy would help to lean ‘against the wind’.
  • All told, we are now pencilling in two 25bp rate hikes in H2 this year, with the first coming at the August meeting. And the fact that the Norges Bank is not usually timid suggests that further tightening will be on the cards next year. Our new forecast is more hawkish than is currently priced into the market. (See Chart 1.) If we are proved correct, this would provide further support to the NOK, which we expect to be the best-performing G10 currency (see Chart 2) on the back of a wider pick-up in investor risk appetite and oil prices. We now forecast it to reach NOK 9.50 per euro by year-end, from 10.22 at present.

Chart 1: Norway Key Interest Rate (%)

Chart 2: Forecast Changes in G10 Currencies
(%, By 31st Dec. 2021)

Sources: Refinitiv, Bloomberg. Capital Economics

Sources: Refinitiv, Capital Economics


David Oxley, Senior Europe Economist, david.oxley@capitaleconomics.com